Has the US market risen too far too fast?

Markets do not normally go up in straight line. They usually have pauses for reconsideration and bouts of fear. Investors got over their shock and dismay at the election of Mr Trump very quickly. Share markets soon latched on to the reflationary potential of the Trump tax cuts, proposed increased infrastructure spending and more interventionist policy putting America first.

The President elect’s style of influencing developments even before he is in office by tweeting out a commentary on what is happening is becoming better understood. Already he claims to have forced some rethinks in the US motor industry following his requests that more cars be made in the US and less investment is made in car production in Mexico. Whilst he has his critics amongst the Republicans in Congress, he has had some early influence over Republican politicians. We assume he will be able to get some tax cuts through despite the deficit hawks. His plans to boost infrastructure spending always depended more on private money than increased public spending, and will require considerable political will and energy to bring about. Some will happen anyway from the need for more capacity as the recovery matures, and from the higher energy prices that Opec has brought about.

Mr Trump inherits a US economy in good shape. US unemployment is below 5%, wages are rising by 2.9%, employment is still increasing and the economy is expanding at a reasonable pace. Labour force participation remains quite low at 62.7% of the working age population, implying more people may still be tempted into work as wages and vacancies rise. The banking system is sufficiently mended to be able to lend to finance increasing company activity and to help consumers buy larger ticket items including homes and cars. The US is still the dominant internet and digital technology provider to the world, sporting the major international groups that have pioneered the digital revolution. The US has good leading universities and a favourable culture for business start-ups, new ideas, and the provision of capital to early-stage ventures. All this helps the economy grow and gives it a major presence in world markets.

What could go wrong? Mr Trump could make serious errors of judgement and policy.

The Fed held back from rate rises ahead of the Presidential election. They had prepared the ground thoroughly for an increase in December, which duly came. The suggestion is for two or three further rate rises in 2017, which would be justified if the economy continues its advance and inflation becomes more lively. Whilst the banks can finance a modest recovery, there are as yet no signs of bank credit careering out of a control with unreasonably large increases in wages and prices as a result. The new Administration has signalled they would like to alter bank regulation to allow more credit for investment. The Fed will be unwilling to take action which stifles the recovery. It will also be cognisant of the impact rate rises will have on the dollar. The currency has already strengthened a lot, which is a monetary tightening. The Fed will not want to double up the monetary tightening too much, whilst the incoming President will want a more competitive exchange rate to meet his targets for US industrial expansion at home.

What could go wrong? Mr Trump could make serious errors of judgement and policy. He could find it impossible to get through his reflationary package. The Fed could become more aggressive than markets think, with a strong dollar reinforcing the deflationary tendencies of a more rigorous monetary policy. We regard these as low probabilities. The recent news conference was dominated by personal matters and reminds us how difficult it is to avoid “noises off” for modern leaders. We do not know whether Mr Trump will keep his promise of the campaign to name China as a currency manipulator and escalate his war of words with the world’s largest emerging economic power.

It is likely he can do a deal with the Republicans in Congress to get tax cuts through. Speaker Ryan is also a keen tax cutter and reformer. It is also likely that upwards progress in US shares to reflect improving corporate earnings and dividends will from time to time be knocked by worries over protectionism and geopolitics.

The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 13th January 2017.

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